BRUSSELS/BERLIN, Oct 20 (Reuters) - The European Union has
agreed that around 100 billion euros is needed to recapitalise
the European banking system, but deep splits remain before a
high-profile summit on Sunday over how to strengthen the euro
zone's bailout fund.

Sources in Germany's governing coalition said the European
leaders' summit would not reach a decision on increasing the
scope of the European Financial Stability Facility, the key
element financial markets were looking for to combat the crisis.

Failure on that front could further damage market confidence
in the euro zone's ability to tackle its debt crisis,
underscoring how the crisis is both economic and political, and
perhaps more intractable because of that.

Progress was made in other areas.

EU officials said all 27 member states had agreed that just
short of 100 billion euros ($138 billion) was required to
bolster bank balance sheets, a substantial step forward in
attempts to protect the system against the threat of a default
in Greece or elsewhere.

"The figure has been discussed with member states. It is now
acceptable for everybody," an EU source involved in the
discussions said.

Banks will be required to come up with the capital from
shareholders first, and if that fails than national governments
will provide the support. Only as a last resort will the EFSF be
used to recapitalise institutions.

A deal on recapitalisation clears one hurdle for leaders
ahead of the Sunday summit, but there remain large areas of
disagreement, particularly over how to scale up the EFSF rescue
fund to equip it to defend the likes of Spain and Italy.

The sources in Germany said Chancellor Angela Merkel would
not address the German parliament before she leaves for
Brussels, making an agreement on the fund impossible at the
summit as it will not have the Bundestag's stamp of approval.

The International Monetary Fund and the EU also do not see
eye-to-eye over the sustainability of Greek debts, with the IMF
concerned that EU projections may be too optimistic and that
deeper debt reduction is needed, EU sources told Reuters.

Despite the differences of opinion, the inspectors are
expected to go ahead and approve an 8 billion euro aid payment
to Greece next month, the sixth tranche from a 110 billion euro
package of EU/IMF loans agreed last May.

Without that payment Greece faces default, possibly dragging
the larger economies of Spain and Italy into the mire and
sending shockwaves through the European banking system.

In their effort to agree a comprehensive crisis resolution
plan, euro zone leaders are striving to agree new steps to
reduce Greece's debt, strengthen the capital of banks and
leverage the EFSF to stem contagion to bigger economies.

Analysts say the key element is how to leverage the EFSF, a
440 billion euro fund set up last year and used to bail out
Portugal and Ireland.

French President Nicolas Sarkozy flew to Frankfurt on
Wednesday for emergency talks with German Chancellor Angela
Merkel, the head of the IMF and other top euro zone officials.
French media reported he missed the birth of his daughter in the
process.

France has argued the most effective way of leveraging the
EFSF is to turn it into a bank which could use funding from the
European Central Bank, but both the ECB and Berlin oppose this
and the proposal now appears to be dead.

Instead, there is an initiative to use the EFSF to guarantee
a portion of potential losses on new euro zone debt, a way of
trying to restore market confidence that Italian and Spanish
bonds are safe to buy. By guaranteeing only a portion, perhaps a
third or a fifth, of each debt issue, the EFSF's funds would
stretch 3-5 times further.

Analysts are concerned that such a plan could create a
two-tier bond market, with bonds that have guarantees trading at
a premium to the secondary market -- an outcome that would
likely fuel the turmoil markets are already in.

Markets caught up with the downbeat tone. European shares
fell, having risen this week on hopes of decisive
action from euro zone leaders. The euro weakened on
reports that the summit could be postponed, then rebounded when
the reports were dismissed.

"I don't think they can meet expectations. The summit will
fall well, well short of the kind of big bang needed to reassure
the markets," said Simon Tilford, chief economist at the Centre
for European Reform in London.

Guidelines for changes to the bailout fund obtained by
Reuters confirmed it will be able to buy bonds on the secondary
market once a request from a country is approved by ECB and euro
zone finance officials.

A draft statement for Sunday's summit showed euro zone
countries will make rules to limit budget deficits and public
debt part of national legislation by the end of next year.

But the statement gave no indication of progress on the main
areas of dispute -- particularly the leverage issue.

FORCED BANK LOSSES?

Adding to uncertainty, EU officials said there was growing
acceptance among key euro zone member states that further
private sector involvement in Greek debt reduction may have to
be forced, not voluntary -- an outcome ruled out up to now.

"Let's be serious, everybody knows that a 50 percent
haircut, as Germany is asking for, is not a voluntary move," one
EU official said. Leaders will also have to agree on a new
bailout package for Greece, one that is expected to be at least
110 billion euros, not including the private sector's role.

In July, private investors agreed to contribute 50 billion
euros to reducing Greece's debt via a debt buyback and swap
agreement, which equated to a 21 percent writedown. That is now
seen as insufficient to make Athens' debts sustainable.

Greece remains mired in recession and its overall debt is
forecast to climb to 357 billion euros ($492 billion) this year,
or 162 percent of annual economic output -- which few economists
believe can be paid back.

While Europe's leaders rush to stop a larger writedown of
Greek debt infecting others in the euro zone, ordinary Greeks
are raging at the prospect of years more pain as the price of
help from international lenders.

Clashes between rival groups of protesters broke out in
front of the Greek parliament, interrupting a rally by tens of
thousands against a tough new package of austerity measures due
to be approved later in the evening.
(Additional reporting by Gernot Heller and Madeline Chambers in
Berlin, Andreas Rinke and Luke Baker in Brussels and Michael
Shields in Vienna; Writing by Mike Peacock; editing by Janet
McBride)